New York Markets After Hours

J.P. Morgan is too-big-to-regulate, critics say

RonaldD. Orol

WASHINGTON (MarketWatch) — J.P. Morgan Chase’s revelation of its surprise trading loss of more than $2 billion has renewed questions among former regulators and other observers about whether U.S. regulators can exercise adequate oversight of global bank operations.

“Regulators would be better to focus on simple rules that rely on incentives like capital and risk retention and even with the Volcker rule focusing more on compensation incentives for trading,” said Bair.

Bair and other critics, noting that the losses stemmed from trading in credit derivatives, have also voiced concern whether such trades would contribute to systemic problems in a more volatile economic scenario.

J.P. Morgan's big loss: The lessons

(4:01)

J.P. Morgan's trading blowup shows that large banks still are far too big to manage -- and is a reminder to regulators of the need for clear playbooks to wind down failing financial behemoths without bringing the system down.

But the trades also raise questions about the ability of U.S. regulators to effectively monitor and understand the systemic implications of trades taking place in jurisdictions outside the U.S.

Questions are likely to be raised at the company’s annual meeting scheduled for Tuesday, where nonbinding but influential shareholder votes on pay packages of top executives will be tallied.

J.P. Morgan
JPM, -0.62%
announced that Ina Drew, the head of the bank’s London-based Chief Investment Office, will resign as well as the head of its London CIO office, trader Javier Martin-Artajo, in the wake of the trading loss. It is unclear whether trader Bruno Michel Iksil, dubbed “the London Whale” for the big position he took in credit derivatives, will also depart.

Robert Litan, a senior fellow at the Brookings Institution in Washington, said U.S. regulators have difficulty monitoring and regulating operations of banks with global operations. He said the cross-border issue could be limited if U.S. regulators clarify what kinds of hedging could be permitted in light of the J.P. Morgan transactions.

Kurt Schacht, managing director of CFA Institute in New York, said a major problem for U.S. oversight is that U.S. regulators have not set up systems with the U.K. to cooperate and exchange data. Schacht said that he would be more comfortable if the U.S. Financial Stability Oversight Board and the European Systemic Risk Board were fully cooperating.

“U.S. regulators have access to everyone they regulate and have jurisdiction over, but if the counterparties of those U.S. institutions are other institutions in Europe, they may not have that information,” Schacht said. “The FSOC and ESRB should be cooperating, and that system isn’t set up yet...it’s a reason why the Fed may be having a difficult time figuring this out yet.”

Bair, a Republican who is now a senior adviser at the Pew Charitable Trusts, added that the trade indicates that J.P. Morgan and other big banks are too big to manage.

“I think Jamie Dimon is a very talented manager and I think J.P. Morgan is the best managed of the megabanks, but can even a talented manager manage a $2 trillion institution that is trying to be a commercial bank and derivatives dealer and fixed income market maker with international operations and investment bankers?” Bair asked. “Can anybody really manage that, much less regulate it appropriately?”

Some improvement, but not there yet

Nevertheless, Donald Kohn, member of the Bank of England interim Financial Policy Committee and former vice chairman of the Federal Reserve, said that since the financial crisis of 2008 the Fed has improved its coordination and cooperation with other countries including the U.K.’s securities regulator, the Financial Services Authority.

He added that the Financial Stability Board, an international bank regulation standard setter, has helped improve communications among bank supervisors in different countries.

Kohn noted that the Fed and other regulators have been aware of the J.P. Morgan trades and he didn’t think the U.S. regulators are responding to the trades any slower because they took place in the institution’s London office.

Kohn added that a key aspect of the Volcker rule -- regulation that is in the process of being approved that would prohibit speculative trades by big banks -- is a requirement that banks supply regulators with data flow information so regulators can monitor more effectively what is going on.

He added that whether that data was coming from London or from the U.S., the Fed would receive it at the same speed.

“I doubt that it being in London affects the speed of the regulatory response,” Kohn said.

Bair added that she believes that regulators have the authority to order J.P. Morgan to simplify their legal structures and move the high-risk derivatives activity outside of the insured-commercial bank and put it in a separately capitalized unit. She added that regulators also have the authority to set up separate intermediate boards that are focused specifically on the kind of higher risk activities taking place outside of the insured commercial bank where depositors put their funds.

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